They each earn income (Y); they each spend and consume (C ); they each save (S).

Bob Carol Ted Alice $1000 $1,500 $1,200 $900 $800 $1,100 $1,000 $200 In a wholly Private Economy, Saving and Investment are Brought into Balance with an Interest Rate of, say, 5%. Bob Carol Ted Alice Income $1000 $1,500 $1,200 $900 Consumption $800 $1,100 $1,000 Saving @ 5% $200 $400 $300 -$100 Rate of Interest S 5% D Loanable Funds $800 Net Saving by Bob, Carol, Ted, and Alice is $800. Borrowing and Investing by the Business Community is $800.

Bob Carol Ted Alice $1000 $1,500 $1,200 $900 $800 $700 $1,100 $1,000 Suppose that, with the Interest Rate Still at 5%, Bob and Carol decide they’d like to save more. Bob Carol Ted Alice Income $1000 $1,500 $1,200 $900 Consumption $800 $700 $1,100 $1,000 Saving @ 5% $200 $300 $400 $500 -$100 Rate of Interest S S surplus 5% D Loanable Funds $800 $1,000 Now, net Saving by Bob, Carol, Ted, and Alice is $1,000. But Borrowing and Investing is still $800.

Bob Carol Ted Alice $1000 $1,500 $1,200 $900 $800 $700 $720 $1,100 With a Surplus of Loanable Funds, the Interest Rate falls to 3%, So, Bob, Carol, Ted, and Alice all make adjustments. Bob Carol Ted Alice Income $1000 $1,500 $1,200 $900 Consumption $800 $700 $720 $1,100 $1,000 $1,030 $910 Saving @ 5% Saving @ 3% $200 $300 $280 $400 $500 $470 $290 -$100 -$130 Rate of Interest S S surplus 5% 3% D Loanable Funds $800 $910 $1,000 Now, net Saving by Bob, Carol, Ted, and Alice is $910. And Borrowing and Investing is also $910.

This is the market at work for you and for me. Bob Carol Ted Alice Income $1000 $1,500 $1,200 $900 Consumption $800 $700 $720 $1,100 $1,000 $1,030 $910 Saving @ 5% Saving @ 3% $200 $300 $280 $400 $500 $470 $290 -$100 -$130 This is the market at work for you and for me. When people save more (i.e., when they consume less), the interest rate falls. The business community responds by borrowing more funds and using them to expand the economy’s productive capacity. Resources freed up by the reduced consumption are used for creating plant and equipment and engaging in longer-term production activities. Saving also means increased buying power in the future---when the expanded investment activities have come to fruition. Rate of Interest S S 5% 3% D Loanable Funds $800 $910 $1,000